When the Civic Federation last week released its five-year budget road map for the state, it raised a few eyebrows.

Among the various recommendations made by the group for the state to pay off its bills and gradually reduce its income tax rate, the federation recommended that retirement benefits in Illinois be subject to the state income tax.

Illinois does not now tax retirement benefits, and the idea of imposing a new tax on a powerful voting bloc like seniors had lawmakers quickly declaring the idea D.O.A.

“Taxing retirement income is a very tough issue because we are talking about seniors,” said Sen. John Sullivan, D-Rushville. “I guess putting it on the table is something that we could look at, but I don't see that there's going to be a lot of support to do that.”

“The average taxpayer in Illinois does more than their fair share in paying taxes,” said Sen. Sam McCann, R-Carlinville. “I'm not extraordinarily open or receptive to the concept of asking retirees, after they've worked all their lives, to continue paying.”

Tread lightly

Senate President John Cullerton, D-Chicago, found out just how volatile the issue is when he gave a talk at a City Club of Chicago luncheon in 2011. Cullerton suggested the idea of taxing pensions and payments from 401(k) accounts could be part of an overall discussion about revamping the state's outdated tax system. He was quoted in news accounts as saying it was a matter of fairness.

Within a day, Cullerton was backtracking and saying that taxing retirement benefits would only be done in the context of bipartisan support, protection for low-income retirees and using the money to lower overall tax rates.

Civic Federation president Laurence Msall said the issue had to be raised because the state remains mired in financial problems.

“The temporary income tax increase was not a comprehensive solution. It hasn't fixed the problem,” Msall said. “The state still has $5.4 billion (in unpaid bills).”

That Illinois raised the income tax by 67 percent and still has more than $5 billion in unpaid bills is “unprecedented” Msall said. The state has also cut spending and will have to cut substantially more if the temporary income tax is allowed to expire on schedule at the end of the year. All of this underscores the need for a more comprehensive approach to solving the state's financial problems, Msall said, and that includes looking at taxing retirement benefits.

“The idea that we can afford to exempt retirement income completely when no other surrounding state and the federal government doesn't makes it an obvious choice for the state to examine,” Msall said. “We can't afford another one to five years of careening from one crisis to the next, which has been the politically attractive solution.”

Page 2 of 3 - ‘Lot of phone calls'

Of the 41 states that have an income tax, Illinois is one of only three that do not extend the tax to retirement benefits. The others are Mississippi and Pennsylvania.

“Just because other states do it doesn't mean that we should,” said Bob Gallo, state director for AARP in Illinois. “Basically this proposal looks at one set of individuals and says lets increase their taxes to solve this problem.”

Gallo said people already retired and those close to retirement did not plan for having their incomes taxed and are not in a position to otherwise make up the lost income. If lawmakers would decide to consider taxing retirement benefits, retirees will let them know how they feel, Gallo said.

“We have 1.7 million AARP members in this state, and if this came up for legislation, that's a lot of phone calls that's going to be going into people's offices,” he said.

The Civic Federation report included justification for its recommendation. The comptroller's office, for example, said Illinois lost $2 billion in individual income tax revenue in the 2012 budget year because it exempts federally taxable retirement income from the state income tax. That amount is expected to grow because the number of seniors in the state is expected to grow from 1.7 million in 2010 to 2.7 million in 2030.

“The Civic Federation recommends that the state of Illinois broaden its income tax base to include federally taxable amounts of retirement income to create greater equity among taxpayers and facilitate the gradual rollback of the income tax rates for all,” the report recommended. “The broader base will also ensure greater long-term sustainability of the state's resources by assessing a growing portion of the economy.”

“Illinois has a flat rate tax,” Msall said. “We're taxing the poorest, the lowest income generating working people and exempting the highest retirement income generating people. There's a clear inequity there.”

First $50,000 exempt?

The Center for Tax and Budget Accountability has long pushed for the state to extend the income tax to retirement benefits and for much of the same reasons. The number of seniors in the state continues to grow, and the state doesn't collect income taxes on their retirement benefits.

“It's just too much of a hole for our system to overcome. You're taking too much out of the (tax) base for no legitimate reason,” said executive director Ralph Martire.

At the same time, Martire said, a “significant” portion of retirement income should remain exempt from the income tax. He said the state could exempt the first $50,000 of retirement income and the state would still collect $500 million in revenue. Exempting the first $50,000 of retirement income would also mean that more than 70 percent of seniors wouldn't have to pay the income tax on their benefits, he said.

Page 3 of 3 - The Civic Federation report made a number of recommendations besides taxing retirement income. It called for extending the temporary income tax hike for a year and then gradually reducing it over the next several years to a final individual rate of 4 percent. The individual rate was 3 percent before the tax was increased.

Msall said overall reaction to the federation's recommendations has been mixed.

“It's not a popularity contest. It's a financial plan,” he said. “From people most aware of the seriousness of the problems, it has been received more positively.”